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Introduction

Using my portfolio fundamental rules (here), I used the CCC list (here) to select a Contender to research. The Nippon Telegraph and Telephone (NYSE:NTT) Corporation is a Japan based telecommunications company founded in the 50s and incorporated in 1985. It is the largest telecommunications corporation in the world in terms of revenue. It is listed on many exchanges around the world and has one-third ownership by the Japanese government. NTT is a holding company for regional, long distance, data and mobile communication companies. SA provided a transcript of the latest earnings call (here).

Quick Facts from Google Finance

Price (12/6/2013)

$25.37

P/E Ratio

11.01

Dividend Payout

Semi-Annual

Prev. Year Dividend

0.924

Yield

3.5%

Prev. Year EPS

2.3

Payout Ratio

39%

Beta

0.33

Business

On the latest investor call, the CEO highlighted that the past couple of years have shown some complexity and costly concerns in the company's operations. He noted that 2 years ago NTT had troubling performance. This was followed by poor performance from DoCoMo (NYSE:DCM) last year and the poor performance continued this year from the subsidiary NTT Data. To fill this gap, last year management announced a medium-term plan that pushes the company to continue to expand beyond the Japan market as well as expand functionality and product offerings. This plan is inclusive of making additional investments in current trends such as global cloud services. This can be seen recently by two investments in the United States market. NTT purchased Virtela Technology Services and purchased 80% of RagingWire Data Centers. Acquisitions will help fuel already growing foreign revenues. In the previous year, foreign revenues increased by almost $1B. This is of course a small amount compared to the $105B in revenue the organization brings in, but it does show a successful effort to move beyond the Japanese market and a continued effort to invest in trending technologies. The current plan is to focus on United States expansion and then continue growth into emerging markets.

Outside of new revenue, there is an increased focus on cost. The company has called for a plan to reduce costs by $4B. In the recent announcement they have confirmed that the company has hit 70% of this value ($2.7B USD). The plan still has a year and a half to go. This puts the company on target to meet this cost reduction number.

For the rest of the year, the company left the forecast unchanged. During the first half of the year the income performance was down roughly $100M USD. The goal for the year was to grow net income by $300M USD. The team at NTT believes this is still possible leaving a growth of $400M in the second half of the fiscal year. The resulting estimate is a net income of $1.1B USD.

Any telecommunications company needs to continue investing in the network to keep up with the user's demand. As the trend continues towards all things mobile, NTT must continue to invest in its network. The 2020 Olympics in Japan will demand an estimated 50-fold increase as compared to today's usage (calculated by comparing the incremental need from the London Olympics). NTT has a large investment to make to put the company in good standings in front of the world stage in just six years.

Last, the company reiterated that it is going to continue to focus on the investor. This means the company is still in line to grow the dividend. Below is a recap of the dividends paid over the past 10 years.

Financials

Below is a summary of year-end financials for the past 10 years. Looking at the data there are a few key things to point out. First, EPS growth is negative over the past 10 years. Additionally, other key metrics are declining such as FCF/Share and resultantly Share Price. Not all metrics are bad. Over the 10 years, three metrics have gone in the correct direction. The dividend has shown impressive growth. It is important to note that as revenue declines, more of the dividend is coming from an increase in the payout ratio. Also on the positive side, the debt to equity continues to decline. It has been cut in half over the past 10 years. The last metric that works in investors' favor is shares outstanding. In 2004, there were 3,171M shares outstanding. In 2013, there were only 2,423M shares outstanding. The buyback program shrank outstanding shares almost 25%.

3/1/04

3/1/05

3/1/06

3/1/07

3/1/08

3/1/09

3/1/10

3/1/11

3/1/12

3/1/13

Revenue / Share

34.28

34.53

37.25

38.36

38.15

38.21

37.97

38.43

40.65

43.57

EBITA / Share

11.94

12.73

12.21

11.88

12.76

12.21

11.97

11.99

12.48

12.92

EPS (Diluted)

2.01

2.27

1.71

1.7

2.28

1.98

1.84

1.9

1.81

2.13

FCF / Share

5.3

3.89

3.76

0.47

3.94

1.78

3.33

3.49

2.53

1.91

Share Price

28.34

21.85

21.55

26.41

21.68

19.03

21.02

22.49

22.62

21.74

Dividend / Share

0.241

0.241

0.286

0.363

0.505

0.624

0.69

0.822

0.924

0.409

Debt to Equity

0.97

0.84

0.79

0.68

0.64

0.65

0.58

0.57

0.55

0.49

Payout Ratio

12%

11%

17%

21%

22%

32%

38%

43%

51%

19%

Shares Outstanding

3,171

3,095

2,863

2,764

2,755

2,691

2,647

2,646

2,551

2,424

Source: GuruFocus

Dividend

The reason to buy any utility is for the dividend. NTT has shown an impressive trend of 11 years of payouts. Additionally, NTT is growing that payout pretty aggressively. Over the past 10 years, the dividend has grown at a compound rate of 18%. This has not been consistent over the years and has been slowing to around 12% to 16% in the past 1 and 2 years. This is still a fantastic rate when the base yield is 3.5% or 86% more than SPY. It is important to remember that share price appreciation will be lower than most other industries. Keeping that in mind, the total return over the past 10 years has not been good for most investors.

As mentioned and shown above, the majority of the dividend growth has come from an increase in the payout ratio. While the ratio is currently safe, around 50%, NTT cannot continue to grow the dividend at current rates without income growth.

Dividend CAGR

18%

10 year

13%

5 Year

16%

2 Year

12%

1 Year

Discounted Value

Calculating a discounted value, I use a discount rate of 12%. Based on current earnings of $2.13 with a growth rate of 10% over the next 5 years and 5% over the next 15 years, I calculated a value of $25.64. The current price of $25.37 sits right up against my calculated fair value. This is a conservative estimate of their growth as provided by the company as well as by analysts covering the company.

Conclusion

NTT is currently trading at a P/E ratio of 11. This is below NTT's historic P/E. I think there is a good reason for the decline in the P/E ratio. NTT continues to have performance issues with a new business unit every quarter. Additionally, it has some expensive investments to make over the next 5 years. While these are negatives, there is upside. The company is committed to shareholders and has shown that through share repurchases and growing dividends. It also is reducing costs and its debt to equity value is great.

NTT is too trouble for my dividend growth portfolio. I want to see consistency in the EPS before I am ready to invest. I am also concerned that the growth in the dividend is just from incremental payout ratio.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Nippon Telegraph And Telephone Is Too Troubled For My Dividend Growth Portfolio